Edition: March / May 2017
Editorials

INSIDER TRADING 2

A way to make mega millions

With a little help from one’s friends...

What’s really neat about getting inside information is getting to trade on it without fear of sanction. How so?

The facts, were they to emerge, can add another dimension for debate in the Gupta imbroglio. To illustrate, take this entirely hypothetical example:

Mr X is an employee of an asset-management firm. A few days before presentation of the national Budget, an “impeccable source” tells him of a certain proposal that will hit the exchange value of the rand. Confident in this certainty, Mr X plays the market in fixed-interest securities effectively to short the rand.

Immediately after the Budget announcement, once the rand has been smacked, he buys in at the lower price and cashes a profit determined only be the size of the position he has taken. It can amount to millions of rand, and then some.

In any conversational understanding of the term, this would be insider trading at is most brazen. But it needn’t even be investigated, let alone be worthy of jail time. This is because it appears to fall outside the scope of the Financial Markets Act.

Legally, it would seem, neither Mr X nor his firm are insiders. And neither would seem to have committed an offence despite having profited from information to which other investors weren’t privy and thus were prejudiced.

The preamble to the Act says that it is intended “to prohibit insider trading and other market abuses”. But it narrowly defines an “insider” as “a director, employee or shareholder of an issuer of securities on a regulated market to which the inside information relates, or having access to such information by virtue of employment, office or profession”. It’s argued that Mr X and his firm fall into none of these categories.

Further, under the Act, “inside information” means “specific or precise information which has not been made public and which is obtained or learned as an insider and (which), if it were made public, would be likely to have an effect on the price or value of any security listed on a regulated market”. Again, it’s argued, Mr X and his firm don’t qualify.

They aren’t “insiders”, except that the definition also extends to people who know that the information source is a person employed by a securities issuer. In this sense, where government bonds are affected and the information source is a government leak, the prohibition surely does apply. On the other hand, it might be easier to extract water from a stone than to expect disclosure of the information source.

Under JSE rules, short selling is allowed. This is where a stock, which the investor doesn’t own, is sold in anticipation of it being bought later at a lower price. However, the rules disallow “naked” short selling; where the investor shorts a stock without first borrowing it or determining that it can be borrowed. No problem here for an asset manager.

Now take a situation that’s less hypothetical. It concerns a Sunday Times report about litigation between Eric Wood and his former partners at asset manager Regiments Capital. Wood, an executive director of Regiments between July 2004 and February 2016, has been chief executive of Trillian Capital from March this year.

Wood, Regiments and Trillian are all alleged by the newspaper to have some sort of Gupta connection. Trillian chairman Tokyo Sexwale has commissioned an inquiry by Geoff Budlender SC into state-capture allegations affecting his group.

The Sunday Times has also reported, presumably on good authority, that Wood had told a (Regiments) subordinate in October 2015 that Nhlanhla Nene would be fired as finance minister in December 2015. This information proved correct, with predictable consequences for the rand. In other words, Wood and/or Regiments had at least two months to trade on it.

If they did – and there doesn’t seem much point on traders using such information except to trade – obvious questions for them are:

  • What trading arose i.e. the extent and dates of trades in fixed-interest securities between October and December 2015;
  • On whose instructions the trades were executed;
  • The amount of profit made from the trades;
  • How these profits were distributed i.e. between individuals, the firm and its clients such as retirement funds.

These are basic questions that the JSE and the Financial Services Board, which regulate the SA securities markets, should put to Wood and Regiments. The regulators have access to records against which responses might be tested. Let’s see whether there are indeed worms in the can, for a prosecution to be launched, and then assess whether the Financial Markets Act needs to be reworked for the ambit of insider-trading offences to be broadened.

The best outcome for Wood and Regiments is that they are seen to have clean hands. The best outcome for the public is that the JSE and FSB are seen to be robust at their jobs.

This article, by TT editor Allan Greenblo, was originally published by the Financial Mail on Nov 25.